WEEKLY COMMENT 28-09-2017
By Barry Edwards
EU Problems Ahead
An interesting short paper was posted by the Cobden centre entitled ‘The forthcoming global crisis`. It is about the likelihood of a recession happening in the next eighteen months and it explains why they believe it could be caused by the sudden rise of interest rates in the Eurozone. The Cobden Centre is a British independent educational charity founded formally to undertake research into economic and political science and to disseminate the results thereof and to advance the education of the public in economic and political science. If you click on the link below you can read the paper, it is about 7-8 pages;
If you have not got time to read the paper below are a few extracts;
“By far the most likely and dangerous source of the next crisis appears to be the Eurozone. The ECB, distracted by the difficulties in Greece, Italy, Spain and Portugal, maintains a bizarre monetary policy of negative interest rates for bank deposits and a monthly injection of €60bn, aimed at keeping government funding costs as low as possible and the weaker banks solvent. The market distortions are extreme, with the “riskless” 2-year German Schatz bond yielding a negative 0.68%.”
“Dollar and sterling interest rates are already rising. The underlying problem for the ECB is they have financed government spending by buying up Eurozone sovereign debt, underwriting inflated bond prices. Governments have got used to artificially suppressed funding costs and will not take kindly to seeing them rise. But even worse, Basel committee rules give sovereign debt a zero-risk weighting for banks, and so the Eurozone’s banks are up to their necks in overpriced government bonds.
Unlike American banking regulators, which since the last credit crisis have forced the US banks to increase their core capital, the ECB has done very little to improve the soundness of Eurozone banks. Therefore, they cannot afford to see government bond yields rise significantly, because the valuation losses will wipe out many banks’ capital. Yet, with the 2-year yield marker still deep in negative yield territory, and the Eurozone economy now demonstrably in the expansionary phase of the credit cycle, here lies the crisis in the making.”
That gives you a flavour of the reasoning but I do recommend that you read the whole paper and its conclusion; it is very well written and easy to read.
Although this paper was posted earlier this week, it was most likely prepared before the German election results. The only creditable coalition for Angela Merkel is now with the FDP and the Greens who will ask for major policy commitments that will restrict her ambitions to accept the proposals for the Eurozone from President Macron that were also announced officially this week. This will probably mean that the Eurozone will not agree on the policies needed to make it more resilient to crises and leave the ECB as the only institution capable of resolving any problems.
Unfortunately, that plays into the hands of the theory behind the Cobden paper leaving the Eurozone very exposed if their predictions are proved correct. Many commentators have seen the potential for financial difficulties arising from the lack of inter-governmental support for the Euro currency and believe this could lead to its ultimate collapse. Obviously, if this did happen it would have very serious consequences for Europe and the rest of the world and would be worse than the financial crisis of 2007/8.
Therefore, there is a lot riding on the German coalition to understand the implications of the need to establish a firm foundation for the Eurozone along the lines of the Macron proposals. The French, the German’s and possibly the Italian’s and Spanish are the main drivers of any improvements for the EU and the currency which must be decided and implemented in the next two years if the problems foreseen are to be avoided. If you take note of the current political discussion amongst the EU members that is not a scenario that looks possible at the moment unless there is a big change in the policies outlined by the coalition members of the next German government.
The Brexit negotiations are dominating the debate in the EU distracting the politicians from concentrating on the structure of the union which is now becoming more important than these talks. In my view and that of many other commentators the survival of the EU and the Euro are at risk if there is not a more positive approach to securing the future of the bloc and the Cobden paper is probably the first of many warnings that must be heeded if this is to be avoided.
That’s all for this week, more observations next week.